Plan Sponsors Can Expect Contribution Increases in 2012

These
increases will affect competitiveness, investment
and job growth and possibly create a further drag on corporate earnings and
cash flow, according to the Mercer and CFO Research Services Redefining
Pension Risk Management in a Volatile Economy survey report.

More than half of the respondents surveyed
(59%) said their company’s defined benefit (DB) pension plan poses at least a
moderate risk to their companies’ near-term financial performance. More than
half of the respondents said the impact of DB plans on company health is a
focus of attention of equity analysts and investors; nearly two-thirds of
respondents said it was a focus of credit analysts and rating agencies.

Respondents cited a number of factors affecting
their pension plan funding, risk management and investment policies. Over the
past five years, market volatility and low interest rates have had the greatest
impact, coming on the heels of the higher funding requirements of the Pension
Protection Act of 2006, the introduction of mark-to-market balance sheet
requirements and expanded disclosure under U.S. and international pension
accounting standards.

“Plan sponsors have made some efforts to manage
their pension risk exposure by making a variety of plan design and investment
changes. However, their efforts may not be enough relative to their benefit
obligations,” said Jonathan Barry, Boston-based Defined Benefit Risk leader for
Mercer’s U.S. Retirement, Risk and Finance business. “With no expectation for a
quick recovery, plan sponsors should evaluate the effects of the recent turmoil
on their future cash requirements, as well as the impact on their P&L and
balance sheet.”

The survey found over the past five years, more than three-fourths (78%) of the employers have made some form of change in their DB plan’s design. Companies have been most likely to close existing plans to new employees (47%), freeze plans for all employees (21%) or terminate their plans outright (13%). This trend toward changing DB plans is likely to continue: roughly one in three of the executives surveyed say it is at least somewhat likely they will freeze or terminate their DB plans in the next two years

“There has been a low level of plan termination in the last five years. Plan termination activity could increase significantly in the next several years,” Barry said during a live webcast.

While relatively small percentages of plan sponsors are currently employing some level of liability-driven investing (LDI), the survey indicated significant acceleration in various risk management strategies over the next few years. Roughly half of sponsors say they are at least somewhat likely to match fixed income duration to their plan liabilities and increase their fixed income allocations. Similar trends also apply to other strategies, such as dynamic de-risking (lowering risk as the funded status improves), lump sum cash-outs for terminated vested employees and annuity purchase.

The survey found that finance executives seem confident in their ability to execute their companies’ DB-plan strategies over the next two years, but not by an overwhelming margin. Forty-seven percent of respondents said the senior finance team at their companies is “very well equipped” to develop and carry out DB plan strategy; another 44% of respondents said their finance teams are “fairly well equipped” to do so.

Despite this confidence, finance executives recognize they face formidable barriers that are largely out of their control. Queried on the obstacles most likely to limit their finance teams’ ability to make needed changes to DB plans over the next two years, more than half of all respondents (56%) cite “economic volatility and uncertainty.” More than one-third of respondents (35%) cite “regulatory or accounting requirements.”

The obstacles most likely to hold companies back are largely external, according to the survey data and to the executives interviewed for this study. Ultimately, the results of the survey suggest, for finance executives weary of managing the volatility and risk that accompany DB plans, there is little relief in sight. However, the good news is finance executives have a clear view of the plan-design and investment strategies that will make that risk and volatility more tolerable—and many finance executives are confident they are well-equipped to make needed DB plan changes.

“We see plan sponsors positioning themselves for rising interest rates or equity market recovery – either would improve funded status and we expect there will be a significant shift from equities to bonds,” said Nick Davies, Washington, DC-based principal in Mercer’s Investments business. “Corporate defined benefit plan sponsors are intently focused on risk management issues and many are poised to make significant changes. The open questions are, how quickly will market changes occur, and do sponsors have the conviction and capability to carry out their intended changes?”

Redefining Pension Risk Management in a Volatile Economy surveyed 192 senior finance executives at U.S. companies with annual revenues of $500 million or more and representing a wide range of industries. All companies sponsor defined benefit pension plans with an asset value of $100 million or more. The research was conducted in October 2011 by CFO Research Services, the research unit of CFO magazine, in collaboration with Mercer.